Margin impact of Apple product transitions overestimated

With Apple's September quarter having come and gone with the only major product transition consisting of slightly cheaper iPods, investment bank Piper Jaffray believes the company is once again in a position to outperform its own margin guidance despite widespread concern.

The Cupertino-based company during a conference call in July guided its September quarter gross margin down 330 basis points sequentially to 31.5 percent, citing expected impact from a mysterious product transition, a full quarter of back-to-school promo sales, and a one time true-up with a manufacturing partner.

The lower-than-expected guidance was of immediate concern to investors, but as analyst Gene Munster points out in a new report Tuesday, the quarter has since ended and none of the company's actions seem to warrant such a drop-off in margins.

"Apple cited new, lower-margin products, but the only new products announced in the September quarter were new iPod nanos with higher capacities at the same prices and a 23 percent price cut on the iPod touch," he wrote. "Considering the decline in NAND Flash pricing has been at least in-line with typical seasonality, it is unlikely that these changes will result in a greater than average sequential GM decline."

In other words, Munster believes the falling cost of NAND flash memory -- historically the most expensive component used in iPods -- will offset any reductions in the retail price of the players instated by Apple.

As for the back-to-school promo, the analyst believes that Wall Street already has a concrete understanding of its effects, which have been communicated well over the years. That said, he believes the impact of this year's promo is being overestimated in terms of its hit on the company's bottom line, yet underestimated in terms of how many additional Macs it helped sell.

Therefore, Munster said he remains confident in his September quarter gross margin estimate of 32 percent, arguing that the conservative margin guidance offered by Apple management was simply a base case used to rein in Wall Street's ballooning expectations, and not an indication of how it expected the company to perform.

Apple also used the same conference call in July to guide down its margins for the entire 2009 fiscal year, which similarly served to rattle investors. The company, however, offered no reason the change other than saying upcoming product transitions will likely involve lower prices on existing products.

To Munster, this is clearly a signal that Apple will introduce new notebooks with at least one model coming in at sub-$1000 recession pricing. While such a move would clearly impact margins, it wouldn't be enough to drive them down to the 30 percent level, he said. Therefore, should the company guide margins for the December quarter down to 30 percent, it would again be seen as a conservative play. On the other hand, an absence of lower-priced Macs could prove detrimental to the company's shares.

"Importantly, we believe investors would see the lack of redesigned, lower-priced Macs as a more significant negative than they would a 30 percent GM guide in the December quarter," he argued. "Net-net, if Apple issues December GM guidance of 30 percent based on lower-priced Macs, the new Macs would be a positive for the stock."

Munster maintained his Buy rating on shares of Apple and held strong to his $250 12-month price target. He included with his report two charts (above), one of which estimates the company's per-share earnings sensitivity to various gross margin scenarios, while the other shows how the company has routinely guided down its margins for the past eight quarters only to smash those estimates when it reports results three months later.

that's nice analysis, a methodical approach instead of the unfounded speculation critics on these blogs sometimes accuse the analysts of.

still, investors should remember he's addressing only profit margins and their effects, and not declines in revenue. While higher volumes lead to higher margins, it's not a 1:1 relationship. Even if it were, a 32% margin for example, on $x in sales, isn't gonna yield anywhere near the profits of a 32% margin on 0.8 x $x in sales, should sales decline that much from the guidance. I'd have liked to have seen him tie his analysis of margins with an analysis of sales expectations.

I assumed the "product transition" referred to was the iPhone 3G, and that Apple's focus on selling them might offset Mac sales. Many Apple Stores seemed to spend the better part of a month (1/3 of the quarter) handling mostly iPhone 3G sales, potentially driving away Mac buyers. And since the iPhone 3G's quarterly impact is much less than a Mac sale, Apple could see a potential revenue hit.

However, it looks to me like a gangbuster back-to-school season more than offset any impact, and Apple is selling huge numbers of Macs through their University and direct channels to college folks. So I think the danger there is substantially less.

In addition, it feels (I have no actual information on this) that their ramp-up of new laptops is significantly behind schedule. Even taking into account the normal rumor-to-reality gap, it still seems like the laptop refresh should have come before October, and we still have no definite word of an Apple event. So this mysterious "product transition" could easily have been put off until next quarter, artificially raising this quarter's margins.

In addition, it feels (I have no actual information on this) that their ramp-up of new laptops is significantly behind schedule. Even taking into account the normal rumor-to-reality gap, it still seems like the laptop refresh should have come before October, and we still have no definite word of an Apple event. So this mysterious "product transition" could easily have been put off until next quarter, artificially raising this quarter's margins.

It's not a question of believing. One is not telling the truth and the other lying. They are both guessing. They are just trying to predict the future, and they don't have a crystal ball. If you put faith in someone else's predictions about the market, good or bad, you forfeit your own chance to understand the market.

It's not a question of believing. One is not telling the truth and the other lying. They are both guessing. They are just trying to predict the future, and they don't have a crystal ball. If you put faith in someone else's predictions about the market, good or bad, you forfeit your own chance to understand the market.

I have to throw a flag on this one. It's clearly illegal procedure.

The entire post makes no sense.

If I put faith in someone's predictions, it's usually BECAUSE I feel I understand the market and have some idea that the person I put faith in understand's what they are doing and that they are not guessing. If I put faith in someone's models or approach to the market, it is usually because I am doing more work to come to that conclusion, and not blindly giving up and just following what they say.

It appears from what you are saying, that is what you would do in listening to others.
If by listening to others, you give up thinking for yourself, then you belong in a mutual fund.
On the other hand, if listening to what others say makes you more educated and well rounded then you gain from it.
(I'll leave off opinions on how to decide who to believe as you listen to people but I think most understand that listening to two sides of an issue is better than listening to only one)

I still think the product transition will be a new mini, resembling a brick - maybe with big holes likes bricks to aid the cooling. Apple hasn't come out with a truly revolutionary (aesthetic) design for a while and I think a new mini with better specs, a redesigned case and a lower price point would be a all it takes to get a huge amount of users to switch to Mac (especially after M$'s horrendous advertising campaign)

Also, Johnny Ives has had years to ponder the design of the mini, let's hope he's been dreaming up something tasty.

I believe the stock has taken enough of a beating where the economic crisis has already been priced into the stock and IMO has been oversold at this point. I'm thinking things will start to pick back up before the end of the year, but don't see it hitting 200 again until sometime next year, but it should get there if things stay on track. Apple is doing very well in a crappy economic environment so when things turn around they are going to be ahead of the pack.

I have to chime in here. I understand apple is apple and they have always and will probably continue to shroud themselves with tight lipped secrecy in relation to new products. BUT... when your company/stock is bleeding like a stuck hog!!!, as a company, you've got to consider your options. Don't get me wrong, I love Apple products and I've made good money with Apple stock. I've owned Apple stock and options in the past. I'm currently short Apple stock and (probably) won't be changing that position anytime soon. Our economy is in the tubes, we all know this. Apple has lost considerably more value (as a percentage) than most companies of it's size and stature. Do I think this is fair or justified? No, I do not! The average investor doesn't care about Apple and it's products, they only care if the stock is going to make them money or not. With that in mind, given what Apple has told us (financials, guidance, blah blah blah), who would want to invest their hard earned money in a company like that? Obviously from the price of the stock, not too many people (with the exception of yesterday's turnaround at 3pm...I'm still scratching my head on that one...Buffet anyone?). IMO, considering Apple has chosen to stick to it's secrecy guns, unless the upcoming product launch is anything but spectacular (think Macbook that doubles as a time machine!), the stock will continue to get hammered and I'll continue shorting it!

I have to chime in here. I understand apple is apple and they have always and will probably continue to shroud themselves with tight lipped secrecy in relation to new products. BUT... when your company/stock is bleeding like a stuck hog!!!, as a company, you've got to consider your options. Don't get me wrong, I love Apple products and I've made good money with Apple stock. I've owned Apple stock and options in the past. I'm currently short Apple stock and (probably) won't be changing that position anytime soon. Our economy is in the tubes, we all know this. Apple has lost considerably more value (as a percentage) than most companies of it's size and stature. Do I think this is fair or justified? No, I do not! The average investor doesn't care about Apple and it's products, they only care if the stock is going to make them money or not. With that in mind, given what Apple has told us (financials, guidance, blah blah blah), who would want to invest their hard earned money in a company like that? Obviously from the price of the stock, not too many people (with the exception of yesterday's turnaround at 3pm...I'm still scratching my head on that one...Buffet anyone?). IMO, considering Apple has chosen to stick to it's secrecy guns, unless the upcoming product launch is anything but spectacular (think Macbook that doubles as a time machine!), the stock will continue to get hammered and I'll continue shorting it!

All it should take for AAPL to hit $250 in 12 months is 30% growth and a PE of 36.

If you think macroeconomic issues will drop growth rates to 15% and hold PE levels to what we have now, you see a $115 price.

Since technology stocks usually lead recovery, it is reasonable to assume that PE levels will improve along with growth.

Historically, the PE has very strong support in the 30-40 range. $195 is a very reasonable target; $250 is possible, but clearly optimistic. $115 assumes the entire economy is going in the toilet and staying there for a few more years.

All it should take for AAPL to hit $250 in 12 months is 30% growth and a PE of 36.

If you think macroeconomic issues will drop growth rates to 15% and hold PE levels to what we have now, you see a $115 price.

Since technology stocks usually lead recovery, it is reasonable to assume that PE levels will improve along with growth.

Historically, the PE has very strong support in the 30-40 range. $195 is a very reasonable target; $250 is possible, but clearly optimistic. $115 assumes the entire economy is going in the toilet and staying there for a few more years.

In a perfect world your numbers are correct. Using your same logic, explain why COP is so undervalued compared to it's peers? I think the explanation is simple....It's no secret that stock pricing is controlled by precious few and a stock is only worth what they are willing to pay. Apple hasn't given wallstreet any reason to buy the stock but has given plenty of reasons to sell it (hence the current price point). If the "upcoming product release" is lack luster, the stock will be hammered. Wallstreet knows Apple is tight lipped. They also know the stock has been more than cut in half lately. With such a steep decline in shareholder value, wallstreet is thinking.....either Apple is sitting on a golden egg, or they're being poorly run. We'll know within the next few weeks which is the case. In terms of "historical"....history has never seen an economy like this. Granted, bread doesn't cost $20, but anyone who thinks the government can fix our economy is sadly mistaken. Until home values stop falling (IMO 1-1.5years), credit becomes readily available to businesses and consumers alike, and consumers start spending again, AAPL will not see much of a rally and will/should decline (minus time machine/Macbook combo....see previous).

Munster said he remains confident in his September quarter gross margin estimate of 32 percent, arguing that the conservative margin guidance offered by Apple management was simply a base case used to rein in Wall Street's ballooning expectations...

I think we can mostly agree that Wall Street's ballooning expectations have
been quite effectively reined in (to the point that the bit has been yanked
through to the back of their head)

what.. that product transition already happened?
I thought that was related to the upcoming macbooks... aluminum enclosures instead of plastic seem much more of a "transition" than a little pricedrop for the iPods?!
Also, weren't there rumors about a dedicated GPU? That would probably be a move to finally embrace gaming... and again more worthy of the term "transition".
So lets wait until, what.. 14th? I'm sure the new macbooks made from one solid aluminum brick in an expensive new manufacturing process, with an expensive nvidia-card will have *some* impact on the GM

As Steve J. has pointed out, he doesn't run his company by watching the stock market. He runs it as a business to maximize profit and keep it as a sound company.

If he ran it to only to keep the investors happy, that would be a short term outlook and we know Steve is famous for his long-term (5 to 10 or more years) outlook for Apple.

I say: Apple. Stay the course. Keep doing what you're doing. It is working. If secrecy has worked for you, keep it up. (Even though, as some articles have pointed out, Apple has ramped back on pursuing leaks of upcoming products). Although I'm sure that Steve doesn't totally ignore the stock market, I say keep up what you're doing Steve and ignore the pundits.

I agree that Apple is a beautifully run and managed company in regards to the product, image, and (some may argue) culture they provide. Apple/Mac has fans the world over with myself being one of them. They are a far better company than most if not all financial companies save perhaps the GoldenSack people. All together too many companies cave to the pressures of wallstreet and investors alike. IMO, Apple has not and will never resort to such. I truly believe this is their blessing and curse! The value of a company's stock being slashed in HALF within the last TWO months is more than a speed bump in the road or blip on the radar! Changing times and conditions call for changing of ways. If Apple continues to rest on their laurels, perhaps this strategy will work out in the end. History says otherwise (coughM$cough and numerous others). When I wrote my first post earlier today, AAPL was actually even for the day, but managed to finish the day down almost 9%. Certainly the price of the stock will fluctuate with the market, but I think anyone long in AAPL has more pain to come. Keep in mind before/if you hate, this is all just my 2cents and should be taken as such.